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Fight Inflation with these TIPS ETFs - ETF News And Commentary

Although current inflation is at low levels, the aggressive
actions by the Federal Reserve have been raising concerns on future
inflation. The rise in inflationary expectations particularly stems
from the recent announcement of another round of quantitative
easing (or QE3).

The Fed will buy $40 billion mortgage-backed security per month
until the job market improves substantially, suggesting that
purchases could continue for quite some time. The central bank also
has declared that it will keep interest rates at exceptionally low
levels until at least mid-2015 as well.

While QE3 aims to improve economic growth and boost employment
in the country, it could increase the burden on consumers in the
form of higher prices. This is resulting in additional fears of
further inflation (read:
Commodity ETFs in Focus as Fed Unleashes QE3
).

Still, the Consumer Price Index (CPI) currently stands at 1.692%
for the month of August, up from 1.408% in July, implying that
while inflation may not be an immediate concern, it could be an
issue further down the road.

While precious metals are one way to protect against inflation,
investors also have a few options in the bond market. Arguably the
best known way in the fixed income world to protect against
inflation is with ultra-safe Treasury Inflation-Protected
Securities (TIPS) ETFs.

TIPS ETFs in Focus

TIPS offer robust real returns during inflationary periods,
unlike their unprotected peers in the fixed income world (read:
Real Return ETF Investing 101
). These securities pay interest on an inflated-principal amount
(principal rises with inflation) and when the securities mature,
investors get either the inflation-adjusted principal or the
original principal, whichever is greater.

Further, these securities provide sufficient benefits to
investors through the TIPS spread, which is the difference between
the yields on 10-year treasury bills and 10-year Inflation
Protected treasury bills. If the inflation rate surpasses the
spread, then investors would earn more on returns and vice
versa.

This strategy not only combats increasing prices, but also
protects future income for the long term. Thanks to these benefits,
ETFs targeting this space are receiving a closer look from many
over the past few years.

We have highlighted below four TIPS ETFs that all target the
TIPS market, but do so in very different ways (see more ETFs in the
Zacks ETF
Center)
. Still, while they are different, any of the following could be
worth a closer look by those who are seeking to protect their
portfolios with safe fixed income securities in case any inflation
comes down the pike in the near term:

Launched in 2009, this fund provides exposure to short-term
securities in the TIPS market. It seeks to match the performance of
the BofA Merrill Lynch 1-5 Year US Inflation-Linked Treasury Index,
before fees and expenses.

The product holds 14 securities in the basket, each having
maturity of at least 1 year and less than 5 years. It offers ample
benefits to investors, as it is less volatile and highly correlated
to inflation when compared to the broad TIPS funds.

The ETF has attracted $974.3 million of assets under management
given its low risk tolerance level. The fund focuses on top rated
bonds with AAA credit ratings, suggesting minimal default risk with
an average maturity of just 3.05 years. Interest rate risk is also
very low for the product with effective duration of 2.27 years.

The fund is cheap charging only 20 bps in fees per year. It also
has a tight bid/ask spread thanks to healthy volumes of about
100,000 shares per day. The ETF returned nearly 2% so far in the
year (as of September 21
st
) but pays little 0.55% in annual dividend yield and 0.44% on
average yield to maturity (read:
Escape Low Yields with These Three Bond ETFs
).

This is the largest ETF in the TIPS space with AUM of $23.2
billion (read:
Seven Biggest Bond ETFs by AUM
). The fund was launched in December 2003. The fund targets the
mid-term TIPS market by tracking the Barclays U.S. Treasury
Inflation Protected Securities (TIPS) Index.

With a holding of 36 securities, the product contains AAA rated
bonds by Moody and AA+ by S&P, suggesting relatively higher
default risk compared to the PIMCO short-term product. It allocates
56% of the assets to mid-term bonds, 25% to long-term and the rest
goes to the short-term bonds; the average maturity of the fund
comes to 9.30 years. Further, the fund has a relatively higher
interest rate risk with an effective duration of 8.30 years.

The product is frequently traded in volumes of about 964,000
shares per day, suggesting minimal or no extra cost beyond the
expense ratio of 0.20%. With an annual distribution yield of about
2.21% and average yield to maturity of 1.42%, the product has
delivered healthy returns of over 5.0% year-to-date (as of
September 21
st
).

Unlike STPZ, this fund seeks exposure to the long-term maturity
of the TIPS market. It seeks to replicate the performance of the
BofA Merrill Lynch 15+ Year US Inflation-Linked Treasury Index, a
subset of the Barclays Capital U.S. TIPS index (read:
Long Term Treasury ETFs: Ultimate QE3 Play?
).

With total assets of $398.5 million, the product is highly
volatile and invests in bonds having a residual maturity of 15
years or more. The effective maturity of the fund came in at 20.56
years.

The ETF however carries a high interest rate risk given the
effective duration of 12.79 years. In terms of credit quality, the
fund boasts top rated bonds from Moody and S&P, suggesting
lower default risk.

Launched in September 2009, the fund holds 10 securities in the
basket and charges 20 bps in fees per year. With daily trading
volumes of 41,000 shares per day, the fund has a relatively wide
bid/ask spread that slightly increases the cost. LTPZ has generated
excellent returns of more than 9% this year (as of September 21
st
) and pays 1.24% in annual dividend yield and 2.88% on yield to
maturity.

Investors seeking a global exposure to the TIPS market may find
GTIP an interesting choice. The fund was introduced in May 2011 but
has failed to attract more investors with an asset base of just
$15.7 million. It tracks the performance of the BofA Merrill Lynch
Global Diversified Inflation-Linked Index, which is a benchmark of
inflation-linked bonds from around the world.

The product holds 54 securities in its basket with an average
maturity of 12.09 years. It largely focuses on mid-term bonds that
make up 46% of the fund. The remaining 42% is skewed towards
long-term with a small 10% going to short-term securities. About
two-thirds of the bonds are top notch (AAA), one-fourth investment
grade and the remainder is either not rated or high yield
bonds.

In terms of exposure, the assets are tilted towards American
securities with 35% share, although bonds from the UK, Brazil and
France round out the top four with a combined 42% share in the
basket.

The product is quite expensive relative to the three
aforementioned ETFs as it charges 40 bps in annual fees from
investors. In addition, the low trading volume increases the cost
of the product in the form of a wide bid/ask spread.

Despite its unpopular nature, the fund produced relatively
impressive returns of 4.60% year-to-date (as of September 21
st
) with an annual yield of 2.10% (read:
Top Four High Yield Bond ETFs
).

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